Chips on our shoulder: Is Europe neglecting design in its semiconductor strategy?

Europe has woken up to the economic and geopolitical importance of semiconductors. Much of the discussion has focused on manufacturing, but developing our design capabilities could be a cost-effective way to enhance our strategic autonomy and economic prosperity.

Semiconductors, the chips that sit inside everything from smartphones and data centres to cars and 5G equipment, underpin most of the modern economy. They have steadily risen up the policy agenda over the past year, as the US–China trade war revealed just how vulnerable the supply of these critical components is. The US leveraged its dominant position to cut off China’s access to Dutch machinery and Taiwanese factories, strangling Huawei and hindering China’s efforts to develop advanced technological capabilities. Over the past few months, Europe’s automotive sector has been rocked by a semiconductor shortage that forced factories to cut production or grind to a halt.

These events have highlighted the threats to Europe’s strategic autonomy, caught in the crossfire of a global trade war and exposed to the vagaries of an undiversified supply chain. Looking further ahead, Europe aims to diversify its economic structure and be at the forefront of the next generation of digital technology. Chips will be integral to this effort, both as an enabler for a range of technologies, from AI to supercomputing, and as an extremely valuable component of the global value chains in their own right. For now, Europe accounts for only 10% of the industry’s market share.

Much of the focus so far has been on manufacturing and on building up Europe’s existing strengths in automotive and industrial chips. However, the expense and level of technological sophistication required mean that it will be years before Europe can develop cutting-edge manufacturing capabilities. Promoting Europe’s chip design ecosystem could be a more cost-efficient way to climb the semiconductor value chain, diversify our economy and carve out a strong position at the technological frontier without abandoning the benefits of interdependence. 

The global semiconductor industry

The semiconductor industry is global, segmented, concentrated and highly sophisticated. Powerful economic and technological forces have resulted in most sections of the value chain being dominated by a handful of companies spread across America, Asia and Europe. Only a few companies, such as Intel, both design and manufacture their chips. Most other semiconductor designers contract out their manufacturing to dedicated manufacturing companies like the Taiwanese TSMC, accounting for over 50% of market share. The technological sophistication required means that only TSMC and Samsung can manufacture the latest generation of cutting-edge chips.

Although only 10% of the global market, Europe has some strengths, such as equipment manufacturers like ASML. One of the most valuable European technology companies, it is the only manufacturer of machines that build the latest generation of chips. This represents a little-heralded success for Europe’s industrial policy – Horizon 2020 supported the extensive R&D required, spanning multiple European countries and organisations, and its development of the next generation of machines is already underway.

Otherwise, Europe has a strong presence in the chips necessary for cars and industrial processes, although these are less sophisticated than the digital chips designed by US companies. The various European companies in this space have some manufacturing capacity but still outsource much of their production. Hence, they have felt the brunt of the semiconductor shortage, as higher value costumers ranging from Qualcomm to Apple are prioritised.

Manufacturing ambitions

In December 2020, 18 member states committed to strengthening Europe’s capacity to develop semiconductors across the whole value chain, including next-generation manufacturing. Likewise, the Recovery and Resilience Facility guidance identifies semiconductor manufacturing as one of the ‘flagships’ that should guide member state plans. In February, German Economy Minister Peter Altmaier predicted that a new Important Project of Common European Interest (IPCEI) would crowd in around $60 billion worth of investment.

Although the documents reference the whole value chain, manufacturing is particularly prominent. European industrial policy has scored some notable successes in building battery manufacturing chains, but the challenges posed by semiconductor manufacturing are of a new order of magnitude. The latest generation of factories cost between $15 and $20 billion, in contrast to the $3 billion raised by Northvolt for two gigafactories. This significantly increases the challenge of crowding in private finance and the cost of mistakes. Alongside the cost, there is a considerable technological risk. Even Intel, the dominant semiconductor company, has struggled to keep up with the latest generation of manufacturing processes, while China has failed to make significant headway despite large investments. Only TSMC and Samsung have succeeded.

Furthermore, for the moment, the applications which European industry specialises in are unlikely to require advanced manufacturing processes at the scale necessary. Developing manufacturing capacity for the more sophisticated semiconductors would likely require American companies to place orders when they already have well established and fruitful relationships with established firms. In other words, it will be extremely challenging to develop the most advanced level of manufacturing capacity over the medium term, at least without convincing an existing market leader to open capacity in Europe. The US is also embarking on steps to secure and expand these supply chains, potentially reducing Europe’s exposure to disruptions.

European policy could instead focus on the less advanced manufacturing capacity that is still critical for sectors like the automotive and can provide economic value-added and additional resilience. This would have to be carefully weighed against the cost, especially relative to alternative strategies like cooperating with the US on diversification or greater stockpiling, but it is much more feasible in the medium term. However, these alternatives to high-end manufacturing would do little to develop Europe’s position beyond exiting niches.

Design diversification

If Europe wants to grow high-value digital sectors and enhance its strategic autonomy, chip design merits as much, if not greater, focus as manufacturing. Designers not only capture the lion’s share of the industry value-add. From a strategic autonomy perspective, they underpin the modern economy just as much as manufacturers. Focusing on design over the medium term need not be seen as an alternative to manufacturing, since strengthening our design industry could support more advanced manufacturing capacity further down the line.

Current indications are that European efforts beyond manufacturing will be concentrated on existing strengths in 5G, industrial and automotive applications, which will grow considerably. Maintaining Europe’s market position is also clearly important. However, the entire semiconductor industry is in considerable flux, creating opportunities for new entrants. Global annual revenues from a new generation of chips developed for cloud computing and AI are forecast to grow by $100 billion by 2030. Their associated geopolitical power and the implications for European strategic autonomy will be significant.

China’s experience demonstrates that it is significantly easier to catch up in design than in manufacturing. Europe already has world-leading research centres like imec, and R&D initiatives like the European Processor Initiative. Europe’s strategy could focus on distributing R&D funding to a broader range of design projects – including through the new Key Digital Technologies Joint Undertaking – and measures to direct private finance towards innovative young companies. After all, the current giants in the field, like Intel and Nvidia, began their lives as start-ups with venture capital funding.

Promoting new entrants in design could be particularly cost-effective and, unlike manufacturing, would not require a handful of expensive investments with a high degree of concentrated technological risk. The $60 billion figure cited by Altmaier for a semiconductor IPCEI is $19 billion more than all European venture capital investment in 2020 combined (the UK included) and 10 to 20 times more than what semiconductor designers like Qualcomm or Nvidia spend on R&D annually.

Europe has traditionally found this kind of industrial policy – nurturing a rich R&D ecosystem and financing young innovative companies – challenging. However, examples like UiPath and Northvolt show how European industrial policy can direct financing towards such companies. ASML’s success shows how European R&D programmes can contribute to technological breakthroughs. For such an approach to succeed, European policy will need to enable more financing for companies to scale up beyond their early stages and to support them to remain centred in the EU, particularly by strengthening the Capital Markets Union. Otherwise, we might see successful companies leaving; UiPath began in Bucharest, but its headquarters and initial public offering are now in New York.

Frederico Mollet is a Policy Analyst in the Europe’s Political Economy programme.

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